U.S. Supreme Court Rules Inherited IRAs are Not Protected from Creditors
On June 12, 2014, the U.S. Supreme Court—in a unanimous decision—ruled that Individual Retirement Accounts (IRAs) inherited by anyone other than a spouse are not retirement assets and as a result will not be protected from the beneficiary’s creditors in bankruptcy.
The rationale behind this is because the beneficiary cannot make additional contributions or defer allocations until retirement, therefore it is not a retirement account. There is, in fact, nothing to prevent a beneficiary from withdrawing funds, or even depleting the account, at any time. Therefore, these funds must also be accessible to satisfy the beneficiary’s creditors during bankruptcy. Following that same reasoning, an inherited IRA is also subject to divorce proceedings, and any other creditor or predator. The funds are no longer covered by a state exemption law and really are now just an outright gift to the beneficiary.
This is not good news for parents who have left large IRA accounts to their children or grandchildren with the intent to continue the tax-deferred earnings for many more years over their lives. Again, these are no longer exempt assets. Creditors and predatory collections and personal injury lawyers or divorce lawyers can get at the money.
Fortunately, there is a way out. By using what I will call a stand-alone retirement trust as the beneficiary of the IRA, you can continue the tax-deferred earnings over a beneficiary’s life expectancy and protect your hard-earned money from the beneficiary’s creditors.
The Key Points
- Inherited IRAs are not shielded from the beneficiary’s creditors in bankruptcy, or anywhere else.
- Using a trust as beneficiary can carry on the tax-deferred earnings over a beneficiary’s life expectancy and protect these savings from the beneficiary’s creditors.
Using a Trust as Beneficiary of an IRA
Using a trust as beneficiary of an IRA or retirement plan account will allow you to utilize the oldest beneficiary’s life expectancy to prolong the tax-deferred growth. You will be able to keep control over when the beneficiary receives distributions, and can guard the asset from the beneficiary’s creditors (including bankruptcy), predators (those who may have undue influence on the beneficiary), irresponsible spending and divorce proceedings. You will also be able to provide for a beneficiary with special needs without risking their government benefits.
For the trust to be qualified, it must meet certain requirements, including that a) it must be valid under state law; b) it must be irrevocable not later than the death of the owner; c) all beneficiaries of the trust must be individuals (no charities or other non-persons) and they must be identifiable from the trust document; and d) a copy of the trust document must be provided to the account custodian by a certain date.
The trust’s oldest beneficiary’s life expectancy must be used to regulate the distributions, therefore many people opt for a separate share for each beneficiary or even a separate trust for each beneficiary. Because they are created exclusively for retirement plan and IRA assets, these are called “stand alone retirement trusts”. (A revocable living trust would still be used for other general estate planning purposes.) We can also create accumulation trusts for greater asset protection.
What You Need to Know
Planning for IRAs and other tax-deferred savings plans is not something to be brushed aside, and certainly not a job to try to do on your own. The laws are intricate, and a simple error can be distressing and irreversible. Because there is often a lot of money involved with these plans, it pays to work with an estate planning attorney who has extensive experience in this area.
- A conduit trust requires that all distributions from the IRA or retirement plan must be distributed to the trust’s beneficiary(ies). (The trust is simply a “conduit” from the plan to the beneficiary.) These distributions are not protected from a beneficiary’s creditors and have no asset protection.
- With an accumulation trust, the distributions may be kept within the trust instead of being distributed to the beneficiary. Assets that remain in the trust are protected from the beneficiary’s creditors, but any undistributed income kept in the trust may be subject to higher income tax rates than what an individual would pay on the same amount.
- A “trust protector” can be provided with the power to modify the trust from a conduit to an accumulation trust. This can be valuable if there is a deviation in the beneficiary’s circumstances (due to disability, drug problems, etc.), making it advantageous to keep the distributions in the trust.
- Your attorney will be able to propose the best combination of beneficiary designations for both the IRA or retirement plan and your Trust(s). Having these options will let your beneficiaries make better decisions based on the conditions at that time. For example, if your spouse is in poor health when you die, it may make sense for your spouse to disclaim an IRA so that your children can inherit it and have distributions paid over their longer measuring lives.
It is essential that you take action to ensure that your IRA can’t be seized by your beneficiaries’ creditors. Call my office now to schedule an appointment. I offer a free initial consultation for estate planning. I will get you in as soon as my schedule allows. I will analyze whether a Standalone Retirement Trust is appropriate to protect your children, grandchildren and assets.
As an estate planning specialist serving Sioux Falls and southeast South Dakota, it would be my pleasure to sit down with you and determine how to accomplish your estate planning goals. I get really excited about helping parents pass on their values, maintain their privacy, and protect their children from creditors, divorce, and bankruptcy. It is actually fun to teach folks about the amazing planning opportunities that are available to everyone.
Call or email today to set up a no obligation appointment to meet with me to review your estate planning needs.
300 N. Dakota Suite, 603
Sioux Falls, South Dakota